Investing in an economic downturn

The market has been preparing for a US/European economic downturn since The Fed started raising interest rates in early 2022. A search of the word “recession” in the Wall Street Journal over the past year generates 3,822 results and in the Financial Times generates 3,414 results. These figures mean that over the past year it would have been possible to read approximately 139 articles a week referring to ‘recession’ in those newspapers alone. If we do head into a recession, it will be the most telegraphed one in our investment history.

Amid all this forewarning and debate, one element has been sorely missing from the discussion. That is, how to make money during an economic downturn. Below we will share some of the strategies Pella has employed to do exactly that. We will start with a review of stock market performance during these periods and then provide three areas Pella is investing in to make money during these environments.

Stock market performance during economic downturns

Historically, stock markets have more often than not generated positive returns during economic downturns.

Figure 1 illustrates the performance of the global stock market (as measured by the MSCI World Total Return Index) during economic downturns. The returns data is based on the quarter preceding the economic downturn to the quarter following the economic downturn. Few of us recall stock market returns pre the 2000s and recency bias and loss aversion means most people will place excessive weight on the experience in the 2000 and 2007 downturns, but the longer-term evidence strikes a different tone. In seven of the eleven past economic downturns the stock market generated positive returns during economic downturns.

Figure 1 - World stock market returns during prior global economic downturns

Sources

Economic downturns - Federal Reserve Bank of St. Louis, OECD based Recession Indicators for OECD and Non-member Economies from the Peak through the Trough, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/OECDNMERECDM,

Stock market performance –MSCI World Total Return Index, courtesy of Factset

Discount retailers

Discount retailers benefit from economic downturns

Consumer spending accounts for approximately 70% of the US economy and 53% of the EU’s GDP. Therefore, most economic downturns in those markets are accompanied by weaker consumer spending. During these periods, consumers don’t stop spending. They change the way they spend by reducing expenditure on discretionary items and trading down for all items (discretionary and non-discretionary). Discount retailers are the beneficiaries of such an environment.

Figure 2 summarises same store sales (SSS) for a sample of North American discount and discretionary retailers in the period surrounding the 2007-2009 US economic downturn, and Figure 3 illustrates the aggregate SSS growth for the companies over the period. All the discount retailers in the sample generated aggregate SSS growth over that period, while all but one of the discretionary retailers’ aggregate SSS declined over that period.

Figure 2 - Sample of North American retailers' same store sales*

	2008	2009	2010
Discount retailers
Dollar General	2.1%	9.0%	9.5%
Dollar Tree	2.7%	4.1%	7.2%
Dollarama	-1.5%	3.4%	7.9%
Ross Stores	1.0%	2.0%	6.0%
Walmart	1.6%	3.5%	-0.8%
Discretionary retailers
Target	2.0%	-2.9%	-2.5%
Best Buy	2.9%	-1.3%	0.6%
Home Depot	-6.7%	-8.7%	-6.6%
Macy's	-1.3%	-4.6%	-5.3%
Dick's Sporting Goods	2.4%	-4.8%	-1.4%
Gap	-4.0%	-12.0%	-3.0%
Nordstrom	3.9%	-9.0%	-4.2%

Source – Companies, Factset

(1) For years ending January or February, for example 2008 is year ending Jan-08 or Feb-08, depending on the company’s end of financial year.

Figure 3 - Aggregate change in same store sales (FY07-FY11) *

Source – Companies, Factset

* For years ending January or February, for example 2008 is year ending Jan-08 or Feb-08, depending on the company’s end of financial year

In recognition of the opportunity for discount retailers during economic downturns, Pella has investments in Dollar General (DG-US), 3i Group (III-GB) – owner of ‘Action’ discount retailer in Europe, and B&M European Value Retail (BME-GB).

Healthcare

Healthcare tends to grow regardless of the economic environment

Health care is a resilient sector with strong underlying long-term tailwinds, so it tends to grow across most economic environments.

Figure 4 illustrates the change in health care expenditure for several countries, indexed to the 2007 expenditure and calculated in current prices (thereby eliminating the impact of inflation). Real health care expenditure grew in every country across the 2007-2009 global recession. This data supports the argument that health care is likely to grow during economic downturn. In recognition of this finding Pella has several healthcare investments, including Novo Nordisk (NOVO./B-DK), IQVIA (IQV.US), Thermo Fisher (TMO-US), and Intuitive Surgical (ISRG-US).

Figure 3 - Indexed healthcare expenditure by country *

Source – OECD, Health expenditure and financing

* Expenditure is in local currency at current prices and indexed to each country’s expenditure in 2007

Summary

There is widespread expectation that the global economy is heading towards an economic downturn. This need not be bad for investment portfolios as historical evidence points to equity markets often delivering solidly positive returns during those periods. In addition, there are certain areas that benefit either economic downturns or can be expected to deliver growth regardless of the economic environment such as discount retailers and healthcare. The key message is that expectations of an economic downturn should not result in pulling back from investing but might refocus the areas one invests in.